EVALUATION OF INFRASTRUCTR PROJECTS guide for cost benefit analysis

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EVALUATION OF

INFRASTRUCTURAL PROJECTS;

GUIDE FOR COST-BENEFIT ANALYSIS

Section I: Main Report

Research Programme on the economic Effects of Infrastructure

Carel J.J Eijgenraam*

Carl C Koopmans*

Paul J.G Tang*

A.C.P (Nol) Verster**

CPB Netherlands Bureau for Economic Policy Analysis* Netherlands Economic Institute**

A copy of this report can be ordered fromAVV Transport Research Centre

T.a.v Louise van der Pol

On the initiative of the Ministry of Transport, Public Works and Water Management and the Ministry of Economic Affairs, a large-scale research programme entitled ‘Economic Effects of Infrastructure’ (OEEI) was carried out The results of OEEI were published in a guide and eight underlying reports

A guide for the evaluation of infrastructural projects.

OEEI offers a guide for the evaluation of proposed infrastructural projects

In this respect, a broad range of effects is described, including methods todetermine the effects The guide makes it possible to present the impacts ofinfrastructural projects in a more structured and transparent way in order tofacilitate decision-making

This publication, titled ‘Evaluation of infrastructural projects: guide for benefit analysis’ forms the main report of OEEI and is, to a large extent,based on the results of eight studies performed within OEEI The guideconsists of section 1, the main report Section 2, selected topics, looking atspecific subjects in more detail such as the valuation of indirect effects andexternal effects is only available in Dutch The eight underlying studiescontain information which, in part, complements the guide and which isuseful when carrying out a cost-benefit analysis

cost-Overview of the studies within OEEI

A1: Economic evaluation of major infrastructural projects: makes aninventory of internationally prescribed evaluation methods in order toextract lessons to improve Dutch practice

A2-1: International benchmarks for performance comparison ofinfrastructure: highlights performance indicators for infrastructure in

a number of West-European regions

A2-2: Markets for infrastructure: provides insight into the relationshipbetween institutional factors such as privatisation and decentralisationand the performance of infrastructure

A3: Spill-over effects of main port projects: provides insight into theeconomic spill-over effects of major investment projects in Europeanseaports and airports

A4: A regional data file for the analysis of the economic effects ofinfrastructure: offers an overview of a regional (panel) data set and

an initial test of the limitations thereof

B1: Welfare effects related to the evaluation of large infrastructuralprojects: provides a basis for the valuation of external effects andpossible solutions for compensation measures

B2: Distributive aspects of large infrastructural projects: provides insightinto the problem of distributive effects and gives recommendations fordealing with these

C: Essentially forward: making practical suggestions for the meticulousevaluation of forward effects and the development of a spatial generalequilibrium model

Commissioned by:

Ministry of Transport, Public Works and Water Management Ministry of Economic Affairs

Colophon

Evaluation of Infrastructural Projects

Contact persons on behalf of both Ministries:

P.W.L Gerbrands, MA (Ministry of Transport, Public Works and Water

Management, directorate Strategy & Coordination)A.L ’t Hoen, MA (Ministry of Transport, Public Works and Water

Management, directorate Strategy & Coordination)

J Prij, MA (Ministry of Transport, Public Works and Water

Management, AVV Transport Research Centre)F.A Rosenberg, MA (Ministry of Transport, Public Works and Water

Management, AVV, Transport Research Centre)

A Westerhuis, Eng (Ministry of Economic Affairs, directorate Spatial

Economic Policy)

OEEI research group:

P.M Blok, MA Eng (KPMG Bureau for Economic Argumentation, chairman)

M van Beveren, MA (Buck Consultants International)A.N Bleijenberg, Ir (Centre for Energy Saving and Clean Technology)P.M.H Bleumink, MA (Buck Consultants International)

L de Boer, MA (KPMG Bureau for Economic Argumentation)Prof E.J Bomhoff (NYFER)

M.A van den Bossche, MA (NEI)

Dr F.R Bruinsma (Free University of Amsterdam)

R Buck, MA (Buck Consultants International)J.M.W Dings, Ir (Centre for Energy Saving and Clean Technology)C.J.J Eijgenraam, MA (CPB Netherlands Bureau for Economic Policy Analysis)Prof C van Ewijk (CPB Netherlands Bureau for Economic Policy Analysis)

L van der Geest, MA (NYFER Forum for Economic Research)

W de Haart, MA (IOO bv)A.R Hoen, MA (IOO bv)T.H van Hoek, MA (CPB Netherlands Bureau for Economic Policy Analysis)B.A Leurs, MA (Centre for Energy Saving and Clean Technology)

M.L.G Lijesen, MA (IOO bv)

Dr C.C Koopmans (CPB Netherlands Bureau for Economic Policy Analysis)

Dr H.J Meurs (MuConsult)Prof J Oosterhaven (University of Groningen)

Dr A.H Perrels (TNO Inro)

J Poort, MA (NYFER Forum for Economic Research)Prof P Rietveld (Free University of Amsterdam)

Dr J Rouwendal (MuConsult)

Dr J.E Sturm (University of Groningen)P.J.G Tang, MA (CPB Netherlands Bureau for Economic Policy Analysis)

O Teule, MA (NEI)

Dr E Verhoef (Free University of Amsterdam)

Dr A.C.P Verster (NEI)

Dr P Zwaneveld (TNO Inro)Interdepartmental consultation between the Ministries of Transport, PublicWorks and Water Management, Economic Affairs, Housing, Spatial Planningand Environment, Finance and Social Affairs and Employment formed

a linked with the practical aspects of policy and implementation

The Committee for Economic Structure (ICES) was closely involved in theproject

April 2000

Over the past few years, economists have held major discussions over thesocial return of large transport infrastructural projects The economic effectswere often estimated with diverse results The Ministry of Transport, Public Works and Water Management and the Ministry of Economic Affairstherefore decided in 1998 to make an inventory of the knowledge ofeconomic effects of infrastructural projects, to promote collaborationbetween institutions and to try and formulate common starting points,definitions and methodologies The departments therefore commissionedthe Research programme on the economic effects of infrastructure (OEEI)

In total, eight studies were commissioned on which separate reports werepublished The results of these studies have been summarised in this guide.The guide was written for the appraisal of all types of transport

infrastructural projects The whole range of effects should be taken intoconsideration when appraising large projects while, when appraising smallerprojects, some effects do not have to be considered, or only need to beconsidered superficially

We can conclude that the aims have been met Leading research institutionshave, in close collaboration, agreed on the concepts to be used, the types ofeffects and the appraisal framework within which all effects should beplaced Applying the guide means that the relevant information is provided

in a transparent and objective manner, which forms the basis on whichpolitical decisions can be made

We are convinced that we have made an important step forward to enhancedecision-making in respect of infrastructural projects This does not excludethe need that the guide should prove its worth in practice In view of this,

we will re-evaluate the guide in two years’ time (early 2002)

The Secretary-General of the Ministry of Transport, Public Works and WaterManagement

The Secretary-General of the Ministry of Economic Affairs

Table of Contents Section I

Preface I Summary and Conclusions I

1 Reason and aim I

2 Results II

3 Evaluation of OEEI IX

4 Set-up of OEEI X

2.1 Why an economic project appraisal? 3

2.2 The results of a cost-benefit analysis 5

2.3 Research during the decision-making process 8

3.1 Types of project effects 13

3.2 Valuation of project effects 15

4.1 The core of the research 21

4.2 Sectional studies 24

5.1 The base case 27

5.2 Scenarios, risks and uncertainty 29

5.3 Direct effects and transport prognoses 32

5.4 Indirect effects 35

5.5 External effects 38

5.6 Distributive issues and employment effects 39

6.1 Nine research steps 43

Literature 51 List of definitions 53

Table of contents Section II

(only in Duth; not included in this publication)

7.1 Standards to determine the return of projects7.2 Risk

7.3 Flexibility and phasing: real options7.4 Conclusions and recommendations

8.1 Transport costs and transport demand8.2 Transport benefits of the project8.3 Generated traffic and locational benefits8.4 Environment and competition

9.6 Conclusions

10.1 What are external effects?

10.2 Method for valuing external effects10.3 Methodological issues

10.4 The compensation issue10.5 Conclusions and recommendations

11.1 What is the relation between CBA and distributive and institutionalaspects?

11.2 Individual and social valuation 11.3 Users and non-users

11.4 Negatively affected and not affected groups11.5 Regions in the Netherlands

11.6 Public private partnerships (PPP)

Literature List of definitions

Summary and conclusions

The past few years, a large number of Dutch economic research institutionshave, commissioned by the Ministry of Transport, Public Works and WaterManagement and the Ministry of Economic Affairs, worked on theInfrastructural Effects Research Programme (OEEI) Discussions on the socialreturn of several large infrastructural projects resulted in this programmebeing implemented Differences in approach and definitions explain partiallywhy appraisals of economic effects of projects vary so much As a result,public confidence in the bases of the projects is undermined, which in turnimpedes a reliable social assessment

Decisions on major infrastructural projects do however have to be made.Such decisions are inevitably associated with great risks which, among otherthings, relate to uncertainty over future developments and effects Undersuch circumstances, a reliable and policy-relevant form of information isneeded

Against this background, the aim of OEEI is twofold:

1 to obtain a greater degree of agreement over the methodologicalframework for social evaluations of major infrastructural projects;

2 to provide research instruments for determining the effects and theircontribution to welfare

OEEI led to the recommendation that, in respect of large infrastructuralprojects, a cost-benefit analysis should be carried out which will serve as

a framework within which an integrated and transparent description ofeffects is possible This recommendation was widely supported by theresearch institutions involved in OEEI The OEEI study looked at all socialeffects which are directly or indirectly linked to the project and offered abasis for determining the contribution to the national welfare It providedtools to describe and, wherever possible, to quantify these effects and theuncertainties surrounding them

These analyses obviously can never replace the considerations made inpolitical decision-making However, they try to ensure that political decisionsare taken on the basis of relevant information, using unequivocal terms andsolid foundations for evaluations

The most important results of OEEI are explained below (section 2) and

an evaluation of OEEI is also given (section 3) Finally, a description of theresearch programme is provided (section 4)

Evaluation of Infrastructural Projects II

The results of OEEI were integrated by CPB and NEI in the report

“Evaluation of large infrastructural projects; guide for cost-benefit analysis”

A summary of this guide in given in this section The guide was based to

a large extent on the contributions from a number of research institutionswhich participated in the OEEI project (AVV, BCI, CE, IOO, KPMG,MuConsult, NEI, NYFER, University of Groningen, TNO Inro, Free UniversityAmsterdam)

Cost-benefit analysis

The most important recommendation of the guide is that, in respect

of large projects, a broad welfare-economical approach should be used This implies that social cost-benefit analysis (CBA) must be used as theappraisal method for government investments

Cost-benefit analysis is firmly based in economic science and is often used inpractice In a cost-benefit analysis, all the effects of an investment projectcan be systematically evaluated and, where possible, given a monetaryvalue In addition, CBA provides an overall picture of the distributive effects,alternatives and uncertainties A comprehensive assessment can only bemade on the basis of complete information

One single figure?

Many effects of large projects can be expressed reliably in monetaryterms Examples are journey time and some environmental effects

However, if distributive issues are involved or an exceptional landscape isaffected, it is impossible to determine useful ‘prices’ In addition, there aremany uncertainties surrounding both the way the project itself works andthe environment in which the project is to be implemented It is thereforeneither possible nor desirable to express a large project in one singlemonetary value

The result of a cost-benefit analysis is a profitability analysis whichincorporates items for which there are no market prices; It also includes asmany other effects as possible for which the value can be determined inother useful ways Effects which cannot be expressed in monetary terms arerecorded separately Although these effects are not included in the

profitability calculations, as much quantitative information as possible isprovided on these In this way, a systematic overview of all costs andbenefits is created The outline below is an example of a cost-benefitanalysis for a fictional project The various types of items in this set-up will be explained later in this summary

Summary and conclusions

Summary of a social cost-benefit analysis for a fictitious project

Amounts in net present values

benefits Environment: emissions

prevented NLG 0.25 to 0.5 bn 2 to 4 m ton CO 2 Total benefits NLG 5.5 to 9.5 bn

PM ITEMS

Distribution effects (between regions) +PM1 10% smaller

income difference Landscape and nuisance –PM2 500 ha 1000

people suffering nuisance

Conclusion: in the political appraisal, the balance in guilders must be weighed up against the PM items which cannot easily be expressed in monetary terms.

The role of CBA in policy preparation

CBA information is useful in almost every stage of policy preparationbecause decisions on the more detailed configuration of project alternativesare continually being taken On the one hand, it is therefore very useful tocarry out a CBA in the early stages of appraisal On the other hand, because

so much information is required to set up a comprehensive CBA, it is reallyonly possible to carry out such a CBA in a late stage of the appraisal process.The solution is to use the blueprint of the CBA as a framework during thephase of problem analysis and the preliminary investigation into variousproject alternatives, but to derive the information mainly from statistics andoverall indicators (pre-feasibility study) This ensures that broad information

on all relevant topics is available when making decisions on gearing theresearch towards promising alternatives Prior to making final decisions onthe project, a comprehensive CBA is carried out In this way, carrying out

Evaluation of Infrastructural Projects IV

a CBA is an iterative process in terms of which certain items are expandedquantitatively and improved during the course of the research Figure 1outlines the role of CBA in the decision-making process

Structure of economic project appraisal

Figure 2 is a schematic representation of the various valid forms ofproject analysis and their mutual relationships The CBA should be seen asthe concluding stage of a large number of analyses As has already beenshown in Figure 1, the steps involved are not taken just once A CBA is,

in many respects, an iterative process Some parts which have beenresearched globally at an earlier stage may need to be revised at a laterstage as additional information is obtained from other research

final problem formulation

project alternatives base case

comprehensive CBA

decision-making

Summary and conclusions

The most important elements of Figure 2 will be dealt with separatelybelow

Clear project alternatives and suitable scenarios (top section of Figure 2) arevery important It is evident that an appraisal of the quantitative effects

of project variants require that these variants be described very clearly.Otherwise an extra, unnecessary source of uncertainty is introduced The environment in which the project will function, however, will inevitably

be characterised by uncertainty in the long term Making use of only oneforecast would merely give the appearance of certainty It is important todetermine the critical factors for success first and then to consider thevarious conceivable developments of these factors In cases where there is

a high degree of coincidence between the factors, it is possible to work withscenarios

The project appraisal (middle of Figure 2) commences with a meticulousmarket and competition analysis This involves looking at (transport) effects

on operators and users and at effects on other modes of transport (networkeffects) The market and competition analysis serves as input for a businessprofitability analysis (BPA) The external effects, including environmentaleffects (MER), can be calculated on the basis of these analyses

External effects are divided into two groups: those which can be expressed

in monetary terms and those which cannot be monetised Non-monetiseddistributive effects are also added These analyses together comprise a

‘partial’ CBA; the word ‘partial’ implies that the analysis includes mainlysectors which are directly affected by the project, and not the wider effects

of the project on the economy as a whole

In other countries, the project analysis often ends with the partial CBA;

in the Netherlands however it is deemed important to include evaluations

of the indirect effects on other sectors of the economy as well whenappraising major infrastructural projects This results in a comprehensive CBA

.

Figure 2

Main structure of economic project

appraisal

definite project alternatives,

‘zero’ alternative and effects

formulating (economic) scenarios

transport effects/market and competition analysis

indirect effects and national economic analysis

business profitability analysis

external effects, including environment & safety

effects which cannot easily

be valued in monetary terms, including distribution impacts

Evaluation of Infrastructural Projects VI

Project and base case

Project effects can be defined as the differences between adevelopment with the project (project alternative) and without the project(base case) Because of this, the construction of the base case is just asdecisive for the outcome of the CBA as the configuration of the projectalternative

In case the project is not realised, sensible choices must be made The basecase is therefore a combination of the best other application of resourcesand the best possible other solution for bottlenecks The base case istherefore something other than ‘not doing anything’ and is also not the

‘existing policy’ For each situation, the best alternative for the project must

be determined Sometimes the implementation of another, much smallerproject is the best alternative, and sometimes it is more advantageous not toreduce the bottleneck through infrastructure,

but rather through another policy Postponing the project is also often

a relevant alternative; this can be included as a variant

The difference between the project alternative and the base case is not onlydetermined by the project itself The construction of the project could, forexample, challenge competitors to make efficiency improvements As aresult, the environment in the project alternative could look different fromthe environment in the base case

Market and competition analysis

The benefits of an infrastructural project are heavily influenced by the value given by travellers or carriers to the new transport opportunitiesoffered by the project This valuation usually becomes apparent in

a transport valuation study The extra transport opportunities are not onlydetermined through infrastructure (for example via network effects) but alsothrough the manner in which the project is developed in terms of forexample price, frequency and number of intermediate stops Users react tothis by making use of the project services in a particular way This results inthe direct benefits of the project being distributed between operators andusers In a CBA an evaluation must therefore be made – in conjunction with

a market and competition analysis – of the behaviour of both the suppliersand those demanding the project services

When preparing decision-making in respect of infrastructure, an Inventory

of Economic Effects (IEE)is often carried out The IEE provides an overview

of the different types of effects of the project, such as cost benefits anddirect effects on employment The IEE however does not offer an integratedpicture of the direct and indirect effects on national welfare It is only theCBA which offers a complete overview in terms of which all welfare effectsare thoroughly and mutually compared The IEE should much rather beconceived as a market and competition analysis supplemented bycomponents of a national economic analysis than as a CBA Against thisbackground, an IEE, at the most, forms a component of the research andnot the centrepiece of the study

Summary and conclusions

Costs

An important element in the analysis are the costs involved inimplementing the project Information on costs is mostly provided by thosepeople responsible for the technical aspects of the project This involvespreparation costs, investment costs during the construction period,development costs during the life span of the project and the costs ofremoval Compensating people who suffer disbenefits as a result of theproject can lead to additional costs

In practice, costs often increase during the decision-making process because,

at the beginning of the process, the costs of additional provision to limitnegative effects are not known This uncertainty should, as far as possible,

be taken into consideration in the project evaluation

In addition, the social costs can be higher than the direct costs This relates

to the missed extra returns of alternative spending of the money

These could for example be the missed extra benefits of tax reductions

Indirect effects

Infrastructural projects have specific characteristics which economicresearch should take into consideration There could be important benefitswhich do not accrue to the users and operators of the infrastructure These

indirect effectscould contribute to an efficient (physical) concentration ofeconomic activities (clusters) As part of the indirect effects, these could alsohave positive effects on Dutch or regional business development conditions

These latter (‘strategic’) effects should be included in economic research.

Indirect effects do not occur in isolation: they result from an improvement inthe transport system and the use that is made of the system The use ofproject services can be divided into two groups: substituting one mode forother modes of transport and generating new traffic The generation of newtraffic is partially connected to indirect effects A clear, quantified

relationship between the generated traffic and indirect effects are often notmade evident in project analyses It is important that the indirect effects areevaluated in connection with the generation of new traffic

Large infrastructural projects do not only affect users and operators Sinceusers pass on a part of their benefit to others, the economy as a whole isaffected This redistribution of benefits can also take place across nationalborders which could be either favourable or unfavourable for the

Netherlands In addition, the redistribution could have a positive impact onwelfare if it results in fewer market distortions which could, in turn, result inthe improvement of efficiency, for example through network effects orthrough scale expansion and/or clustering of companies In order to avoiddouble-counting, it is important to separate these efficiency effects from theredistributive effects

Evaluation of Infrastructural Projects VIII

Methods for evaluating indirect effects

Various methods are available for evaluating indirect effects

It is advisable to employ an approach which accommodates a number ofresearch forms This creates a total picture of the possible range of indirecteffects based on a variety of research methods Indirect effects are oftenevaluated by using the following methods:

1 The macro-production function;

2 Case studies;

3 Targeted fieldwork;

4 Models

By using the macro-production function, the effects on the national

economy of the total investment in infrastructure of a country can beestimated A lot of experience has been gained by this, both within andoutside the Netherlands Unfortunately the results vary substantially so that no clear picture emerges Furthermore, it is not always clear in theseanalyses to what extent high investments are the cause or (also) the result ofeconomic growth (causality) This method is only suitable for analysing total(macro) investments and not for evaluating a specific project

Case studiescan be used to draw lessons from comparable projects, for example, in other countries Since situations and projects are not exactlythe same in different countries, this does not provide an exact picture of

a new Dutch project Nevertheless, such a study can make a usefulcontribution when estimating the order of magnitude of effects (by means

of statistical indicators)

A third method to determine indirect effects is targeted fieldwork: surveys

and interviews This method does not make any comparisons with the past,but looks explicitly at the expectations for the future (which may deviatefrom the past) A problem with this method is that the statements fromrespondents in surveys and interviews do not always correspond with theiractual behaviour

Finally, models can be used These can be used to determine the impact of

the project on the economy as a whole, including an overall estimate of theindirect welfare effects CPB’s Athena model may, for example, be used The direct effects and the results of case studies and surveys can be used asinput when using models to calculate effects This could partially solve theproblem of a model not being detailed enough to avoid drawing ambiguousconclusions In order to examine spatial-economical effects, considerationcould be given to constructing a spatial general equilibrium model

Risks and flexibility

The benefits of an infrastructural project can extend over a number ofdecades As a result, the exact extent of these benefits is often uncertain.The valuation of projects will normally decrease as the uncertainty over thereturns increases This ‘risk-aversion’ can be incorporated in the cost-benefitanalysis by increasing the discount rate by a risk premium in respect ofprojects where the benefits are uncertain (a discount rate of 4% isprescribed for risk-free projects) This ensures that benefits which lie far inthe future are allocated less weight

Summary and conclusions

A better approach however is to highlight the risks explicitly and to valuethem There are various ways of doing this Firstly, the impact of the projectcan be estimated in various scenarios (and possibly in variants of thescenarios) This makes it possible to study the robustness of the project invarious possible developments Secondly, simulations are created on thebasis of probability distributions for specific, uncertain factors; this allowsvaluations to be connected to different possible outcomes as well

Sometimes implementing the project in phases or postponing the project is

a possibility to limit risks; this gives researchers more time to obtain clarity

on certain developments Phasing also offers more flexibility because choicepossibilities remain open at later stages In other cases, the success of theproject depends on the question of which country realises such a project first(first-mover advantage) so that – despite the uncertainty – a rapid

construction has important advantages

of costs and benefits;

- more clarity has been obtained on the use and limitations of themethods;

- collaboration with managing boards of a number of current projects hasled to much practical, reciprocal advice;

- consensus was reached on the issue that project appraisals shouldprovide as much insight as possible into all possible costs and benefits,including relevant uncertainties and risks

It is expected that the description of the social cost-benefit analysis, the possible types of effects and the range of possible calculation methodswill lead to the improved preparation of the decision-making process inrespect of projects Further steps will be possible in future years as thecalculation methods are tested and developed further

This guide has been written primarily for large transport infrastructuralprojects, but is, in principle, also suitable for the analysis of large and smallprojects The whole range of effects related to large projects has beencovered The system of cost-benefit analysis can also be used for smallerprojects In respect of small projects however it is not necessary to examinesome effects (such as the indirect effects) in great detail, if it is at allnecessary to incorporate these

The OEEI project has led to a broad consensus between research institutions

on the importance of cost-benefit analysis when appraising largeinfrastructural projects and on the main features of the method according

to which such analyses should be carried out The organisations involved inOEEI are of the opinion that this consensus has paved the way for the betterpreparation of the decision-making process in respect of projects

Evaluation of Infrastructural Projects X

Introduction

A large conference, initiated by the then secretary-general of theMinistry of Transport, Public Works and Water Management, Van der Plas,was held at the onset of the research programme The conference gave themany researchers another opportunity to set out their various points ofview As a direct result of the conference, the Ministries of Transport, PublicWorks and Water Management (V&W) and Economic Affairs (EZ) took theinitiative to meet the most important panel members on a regular basis for aperiod of one year in order to obtain clarity on which matters there was andwas not agreement and to determine in what areas more knowledge should

be acquired

At the end of that year, the directorate Strategy and Coordination of theMinistry of Transport, Public Works and Water Management and thedirectorate Spatial Economic Policy of the Ministry of Economic Affairsdecided to commission the implementation of the Infrastructural EffectsResearch Programme The Transport Research Centre (AVV) of the Ministry

of Transport, Public Works and Water Management was asked to set upand conduct the research In order to maintain contact with policy-makers,

a steering committee was set up in which representatives of the Ministries ofTransport, Public Works and Water Management (V&W), Economic Affairs(EZ) and co-workers of the Ministries of Housing, Spatial Planning andEnvironment (VROM), Finance and Social Affairs and Employment (SZW)participated In addition, regular consultations took place with the directors

of the various ministries who are involved in setting up large infrastructuralprojects The Committee for Economic Structure (ICES), which was facedwith the choice of a large number of investment options, was kept directlyinformed of the progress of the research Finally, the organisations of thelarge infrastructural projects were also involved in the OEEI project

The AVV invited approximately twenty Dutch research institutions tostipulate their interests in one or more components of the programme

On the basis of this, tenders where invited and, in collaboration withrepresentatives of the various ministries, a selection was made between thevarious institutions Because collaboration is so important, the parties wereasked to work together as much as possible

Results of the various studies

A total of nine studies were commissioned which were categorised infour clusters, namely: International comparison, Welfare aspects, Forwardeffects and Analysis and coherence

A Within the cluster “International comparison”, five research questionswere addressed:

• Evaluation methods Institute responsible: Centre for Energy Savingand Clean Technology (CE)

This research showed that CBA (cost-benefit analysis) is central toresearch carried out in our neighbouring countries (a practice notcurrently followed in the Netherlands) All prescribed methods whichwere considered, have a partial character This implies that the aim

is not to make a complete inventory of the indirect welfare effects The effects are limited to effects in the transport market In somecases, the partial analysis is expanded to include effects on othermodes of transport

Summary and conclusions

• Performance characteristics: Institute responsible: TNO INRO incollaboration with the Free University of Amsterdam

On the basis of information on more than forty European regions,benchmarks were drawn up which were used to determine on whichinfrastructure sub-sections the Netherlands scored well or badly Such

an analysis is useful (if carried out regularly) when drawing up theDutch policy and stipulating accents in the investment portfolio forinfrastructure

• Institutional factors Institute responsible: NYFERThis research looked at the initially attractive statement thatinstitutional factors, such as privatisation and decentralisation caninfluence the profitability of an infrastructural project The statementseems to be partially supported in practice The research highlights the conditions under which this is the case The study relates to twostages in the evaluation procedure; the phase of project definition andthe phase of implementing the CBA in respect of still incompletelydefined organisational options

• Indirect effects of main ports Institute responsible: Buck ConsultantsInternational (BCI)

Within this research, a number of selected main port investmentswere used to determine to what extent indirect impacts of theinvestments can be shown abroad The research showed that hardlyany ex post effect studies were carried out It also showed that theNetherlands, in contrast to neighbouring countries, spend a lot ofattention on determining the relevance of indirect impacts

• Cross section study Institute responsible: (IOO bv)

In respect of this study, a theoretically radical attempt was made to try

to establish the connection between regional economic developmentsand various types of infrastructure investments The quality of thestatistical materials unfortunately seems insufficient to conclude thisstudy effectively within OEEI

B The cluster “Welfare effects” contains two research areas:

• External effects Institutes responsible: MuConsult and the FreeUniversity of Amsterdam

This research provides a basis for the valuation of external effects

In addition, solutions were offered for the best way in whichcompensation can be made

• Distributive aspects Institute responsible: NYFERThis is one of the theoretically more difficult areas and still represents

a gap in our knowledge It is clear that infrastructure causes welfareeffects Policy makers are however also interested in the division ofincome and employment between regions and those parties involved

in the project (users, local companies, residents in the area and taxpayers) The report provided more clarity on the complexity of thisissue It was recommended that an inventory be made of thedistributive effects and to bring the costs and benefits of large projectscloser together, for example, by letting beneficiaries contribute asmuch as possible to the project

C The cluster “Forward effects” consists of one research task and looked atthe most complex subject of all the clusters For this task, the NetherlandsEconomic Institute (NEI), the University of Groningen and TNO Inrojoined forces The report, among other things, showed that the results

of many practical studies carried out in the past are based on ad hochypotheses and global analyses in terms of which the characteristics ofthe specific project were not expressed

Evaluation of Infrastructural Projects XII

Moreover, these studies are often prone to double-counting

In order to prevent this undesired situation, the report made a number ofrecommendations for improvement Two possible solutions were offered:one for the short term (conducting interviews, surveys and targetedfieldwork in a structured way) and one for the long term (Spatial GeneralEquilibrium Model)

D The last cluster relates to “Analysis and inter-connection” and wascarried out by a group of researchers from NEI, the NetherlandsEconomic Institute and CPB Netherlands Bureau for Economic PolicyAnalysis This involved the complicated task of drawing up a well-founded guide on the evaluation of infrastructural projects The analysesand information carried out and collected by the parties who participated

in OEEI were used The most important OEEI results were brieflydiscussed in the preceding paragraphs

1 Introduction 1

This report was compiled at the request of the Ministry of Transport, PublicWorks and Water Management and the Ministry of Economic Affairs withinthe framework of the Research programme on the Economic effects ofInfrastructure (OEEI) The most important aim of OEEI is to achieve greateruniformity in the economic assessment of infrastructural projects in order toprovide project managers and project leaders with a better base from which

to conduct such research

During the last few years, the situation surrounding the economicassessment of large infrastructural projects has been very loosely structured.This was one of the main reasons for setting up the Research Programme.Not only was the assessment characterised by diverse research

methodologies, but many intense, and not always very lucid, discussionsabout the appropriateness and applicability of these methodologies arised.Within the Research Programme, however, consensus has been reached on

a number of crucial points, for example, the importance of implementingcost-benefit analyses The agreements reached within the ‘OEEI community’have been set out in this guide Although much has been achieved, therewill obviously always be scope for further discussion

The guide concentrates on the economic assessment of infrastructuralprojects in the Netherlands, which means that it is not a general manual orreference work for cost-benefit analysis Some topics are only mentioned inpassing or are not discussed at all, while other topics, in particular thosewhich are specifically relevant to infrastructural projects or which focus onthe Netherlands in particular, are discussed in great detail This study isspecifically aimed at transport infrastructure in the form of rail connectionsand (transport) hubs

Is OEEI aimed only at large projects?

This guide has been primarily written for large transport infrastructuralprojects, but can, in principle, be used for the analysis of large and smallprojects The difference between large and small projects lies in the extent ofthe research into the project effects For small projects, it is relatively easy toshow the benefits of the project for a limited number of directly involved,and the effects which it has on others are often considered to be lessrelevant The effects of large projects are more extensive and often diffuse

as a result of their affecting the rest of the economy or the environment aswell This implies that the parts of the guide dealing with direct effects arealso relevant to small projects while the parts dealing with indirect effectsand environmental effects are, in many cases, of less importance to smallprojects

1) Peter van den Berg, Sjef Ederveen, Casper van Ewijk, Taco van Hoek, Herman Stolwijk and Nico van der Windt all contributed to the guide in a variety of ways The authors are very grateful for their contribution.

Notes

Evaluation of Infrastructural Projects 2

Connection with other OEEI studies

The guide is largely based on contributions to the OEEI project made by a number of research institutions (AVV, BCI, CE, IOO, KPMG,MuConsult, NEI, NYFER, University of Groningen, TNO Inro, FreeUniversity) These individual studies have been included in the bibliographyand reference is made to them throughout the text

Structure of the report

The first section of the book, up to chapter 6, is mainly aimed at thosepeople who are more broadly involved in the process (for example policymakers and project managers) In chapter 2, the place of economicassessment in the whole preparation and decision-making process forinfrastructural projects is explained The subsequent chapters deal with thecontent of a cost-benefit analysis In chapter 3, the types of project effectsare described Chapter 4 concentrates on the different parts of a projectassessment Chapter 5 describes the various aspects of measuring projecteffects Chapter 6 offers a step-by-step plan for project assessments The second section, chapters 7 to 11, is published in a separate volume (not included in this publication, only available in Dutch) Section 2 is aimed

at (economic) researchers and supervisors of research projects A number ofdiverse topics are explored in more detail In so far as a more detailedexplanation seems appropriate for professionals and specialists, this will begiven in separate appendixes

2 Research and Decision-making

Decision-making on infrastructural projects is a political-administrativeprocess Section 2.1 outlines why economic research is of the utmostimportance within the decision-making process Section 2.2 describes whattype of information emerges from the research Finally, section 2.3 showshow the research can be used in the preparation and decision-makingprocess

The nature of large infrastructural projects, necessitates active involvement

by the government Economic project assessment contributes to a meaningful consideration of often dissimilar and unequally distributed effects of these projects Cost-benefit analysis is a very suitable instrument for conducting this type of assessment This guide provides

recommendations on how a cost-benefit analysis can be implemented.

The government is currently grappling with decisions on large infrastructuralprojects such as the Betuwe line (freight railway to Germany), High-speedRail Links, a new area for Rotterdam Port Activities or Amsterdam airport.One reason for this struggle is that many of these projects are spatiallydifficult to implement Another reason is that the government is usuallycalled upon to finance large infrastructural projects in particular In a certainsense, the government then adopts the role of an entrepreneur who isconsidering making an investment The government is by nature not verycapable to fulfil this role Furthermore, making decisions is a more complexprocess for the government than for an entrepreneur Whereas theentrepreneur primarily looks at business returns, the government has toconsider the interests of a number of parties

The financial returns from a project are, in many cases, insufficient

to cover the investment costs, but locational or environmental advantagesfor example, could justify the investment from a social perspective

This obviously does not simplify a project assessment Locational advantagesare not immediately perceptible, and there is no market, and therefore nomarket price, for landscapes or noise

Although indirect effects are perhaps less specific, this does not meanthat they are less important One example is an infrastructural project which

is part of a (transport) network Improving a (transport) hub or a linebetween two (transport) hubs could offer benefits further up in the network.The project accordingly does not offer benefits to only the direct users

A further important characteristic of transport is that it fulfils an intermediaryfunction in the economic process This means that the quality of the

infrastructure has a bearing on many sectors in our economy Investments

in transport also relate well to trade and distribution, an area in which theNetherlands has specialised for a long time

These general considerations nevertheless have little to offer as a basis for an analysis of concrete projects It is clear that without electricity, for example, the Dutch economy would grind to a halt This does not implyhowever that the Netherlands build an extra power station tomorrow

Evaluation of Infrastructural Projects 4

Implementing a specific project can have both positive and negativeinfluences on the economy It is only if the benefits outweigh the costs that

we are, on balance, better off in terms of national welfare Economic projectassessment endeavours to assess this To achieve this, all effects are

recorded and made comparable as far as possible, even if these effects coververy diverse areas such as the environment or locational advantages When economic assessments are made on infrastructural projects, the following questions have to be considered:

• Does the project contribute to improving national welfare?

• Which configuration of the project should be given preference?

• To what extent is a financial contribution by the government reasonable? Certain important elements of these questions also apply to two other types

of assessment: administrative and technical assessments In the administrativeassessment procedure, a social problem is identified for which an infra-structural project could offer a solution In addition, it is recognised thatmany different interests are at stake and therefore an attempt is made tofind a solution to the problem which takes into account all interests andwhich is acceptable to as many people involved as possible

The technical assessment procedure tries to find the best possible way

of shaping the chosen administrative solution Although economic factorsare already taken into consideration when choosing between the variousplanning and implementation options, these are confined to options relating

to parts of the project It is often a matter of finding the cheapest solutionfor a clearly defined problem

Economic project assessment includes all aspects of national welfare

Economic project assessment poses a number of fundamentalquestions overlooked by administrative or technical assessment In the sameway as an entrepreneur carries out a profitability analysis when assessing aninvestment project, the government (or society) requires an instrument forcomparing and evaluating various investment opportunities which wouldlead to an acceptable government contribution Economic projectassessment meets this need It is important to note that the word ‘economic’should not be interpreted in the strict meaning of ‘financial’ ‘Economicproject assessment’ looks at the systematic, rational basis of social choicebetween relevant alternatives In addition, all social aspects must be takeninto consideration, including non-financial aspects, such as safety orenvironmental effects Cost-benefit analysis also provides insight into the distribution of costs and benefits among relevant groups in a society Cost-benefit analysis is therefore by definition always ‘social’ in nature and,

in principle, includes all types of effects

Why cost-benefit analysis?

Cost-benefit analysis (CBA) is firmly based in economic science and isoften used in practice In a cost-benefit analysis, all the impacts of aninvestment project can be evaluated and, where possible, given a monetaryvalue In addition, CBA provides an overall picture of the distributiveimpacts, alternatives and uncertainties A comprehensive assessment canonly be made on the basis of complete information; a CBA offers thisinformation

A number of policy documents published by the Ministry of Finance(1993, 1995 and 1998b) accordingly stipulate that state policy shouldalways be evaluated first and that cost-benefit analysis is the perfectinstrument for this

Research and Decision-making

Cost-benefit analysis also forms the basis of the various methodsdeveloped by the public-private partnership knowledge resource centre forportraying and assessing the advantages and disadvantages of public-privatepartnerships, see section 11.6

Why a guide?

Given the fundamental questions raised by a CBA, it is of the utmostimportance that there is agreement on the nature of the CBA This relatesspecifically to the aim, methodology and results This does not only apply toeconomists Other social parties interested or involved who assess projectsfrom their own perspectives and persons from other disciplines, such asengineers and managers, need to know what a CBA involves This guide – in particular section I – endeavours to serve all these various groups The guide contains clear recommendations for the design and

implementation of a CBA geared towards large (transport) infrastructuralprojects, but, in principle, the recommendations can be applied equally well

to small projects These recommendations will not always be immediatelyapplicable and will often have to be adapted when putting a CBA intopractice In this respect, the guide differs from the Handbook for EconomicInfrastructural Effects (AVV, 1996) which provides rules of thumb which areespecially applicable to small projects

In a cost-benefit analysis, all effects of an investment project are recorded and, wherever possible, given a monetary value In this way, a cost-benefit analysis promotes a comprehensive assessment of diverse aspects

In addition, a CBA provides an overall picture of the distribution effects, (project) alternatives and uncertainties.

A CBA describes:

A a comprehensive assessment of different effects;

B the distribution of costs and benefits;

up, it is possible to present information in a well-organised manner whichfacilitates a comprehensive assessment Cost-benefit analyses limit,wherever possible, the compilation of long lists of diverse advantages anddisadvantages which complicate rather than simplify a comprehensiveanalysis of project effects

A cost-benefit analysis also has a disciplining effect because itprevents double-counting It requires an adequate insight into therelationship among the various impacts A cost-benefit analysis thereforemakes demands on the research, not only on the analysis itself, but also

on the underlying research projects This reduces subsequent criticism

Evaluation of Infrastructural Projects 6

A single figure for returns?

The aim of a CBA is to express all effects in monetary terms and toadd them up This however is not possible in practice While (almost) allbenefits and costs for business investments can be given a value in terms ofmarket prices, this is not the case for social investment projects Still, non-priced effects can often be reliably expressed in monetary terms Examplesare journey time profits and some environmental effects How to assess timespent travelling is not immediately apparent, but can be reliably determined

by looking at the behaviour of travellers or by conducting surveys Similarly,although there is no market price for CO2emissions, the costs of measures

to reduce emissions, serve very well as (shadow) prices

Other effects cannot be objectively expressed in monetary terms.Distribution aspects are an example Also allocating a value to non-reproducible, unique goods is a tricky problem: it is not easy to allocate

a price to an area of natural beauty In such cases, other quantitative orqualitative information has to be used Effects which cannot be expressed inmonetary terms must be weighed up in political-administrative terms againstthe sum of the effects which can be expressed in monetary terms

Summary of a social cost-benefit analysis for a fictitious project

Amounts in net present values

benefits Environment:

prevented emissions NLG 0.25 to 0.5 bn 2 to 4 m ton CO 2 Total benefits NLG 5.5 to 9.5 bn

PM ITEMS

Distribution effects (between regions) +PM1 10% smaller

income difference Landscape and nuisance –PM2 500 ha 1000 people

suffering nuisance

Conclusion: in the political assessment, the balance in guilders must be weighed up against the PM items which cannot easily be expressed in monetary terms.

Figure 2.1

A fictitious research report

Research and Decision-making

Figure 2 is an example of a cost-benefit analysis for a fictitious project

A cost-benefit analysis always provides an overview of project effects forwhich market prices are available Effects, the value of which can be reliablydetermined by other means, are also included in the overview whereverpossible Effects which cannot be reliably expressed in monetary terms arereferred to separately These effects are not included in the financialbalance, although as much quantitative information as possible is provided

on these

B Distribution of costs and benefits

The distribution of costs and benefits is extremely important for atleast three reasons, especially for large projects:

1 A distinction must be made between effects for the Netherlands andother countries Because the effects of major infrastructural projectsspatially cover a large area, it often means that there are cross-bordereffects If Dutch tax payers pay for projects, it is important to determinewhat benefits these entail for the Netherlands The division of thebenefits between the Netherlands and other countries must be clearlyshown If the project is (also) aimed at specific regional developments,

it is also necessary to determine the regional distribution effects

2 It is necessary to understand how the users of the infrastructure willbenefit directly from the project The benefits for users form the basis ofthe generation of revenue for a private operator In the case of public-private partnerships, such insight is important for making a reasonabledistribution of the contributions between public and private parties

3 Infrastructural projects often entail some inconvenience for people living

in the area, while the benefits partly accrue to users of the project

As a result of this disparity, it is important to look at the distribution ofbenefits and burdens carefully

The analysis of alternatives lies at the heart of any economic research.This type of analysis entails looking at the returns of a project in comparisonwith alternative ways of making investment resources work for the

community The notion that the cancellation of a project could result in

a loss of income and employment for the Dutch economy is not alwayscorrect This can only be determined after the benefits have been compared

to the alternative returns This is exactly what takes place in a cost-benefitanalysis

The search for alternatives is also very important within the project

In this case, alternatives relate to the timing and scale of the project The advantages and disadvantages of ‘now’ versus ‘later’ and ‘small’ versus

‘large’ should be investigated systematically This also involves looking atbuilding the project in stages Alternatives could also relate to differentlocations or competing modes of transport (for example track versus inlandwaterway transport) Cost-benefit analysis is extremely well suited forcomparing various (project) alternatives systematically and for providinginformation in terms of which the various alternatives can be assessed

D Uncertainties and risks

A long-term perspective is inherent in many infrastructural projects.Decisions on the project are made now, but the effects will often only bevisible in the long term This means that the research must be able to dealwith a comparable long period Firstly, it is important to take into accountthat the future holds many fundamental uncertainties Using one prognosisprovides only the illusion of certainty The customary approach in this case

is, first of all, to determine the critical success factors and then to formulate

Evaluation of Infrastructural Projects 8

various conceivable developments for these factors If there is a connectionbetween these factors, it is possible to work with scenarios Variousdevelopments are often also plausible within the context of one scenario

A supplementary sensitivity analysis should then be carried out

Simulation models can also be a useful tool for assessing the consequences

of various combinations of success factors In this case, probabilities should

be assigned to these factors The advantage of such an approach is that aprice tag can be put on the risk It will often be evident from such analysisthat flexibility in the implementation of a project is of great value

In any event, when conducting a thorough cost-benefit analysis, carefulattention should always be paid to the uncertainties and risks In this way,economic research supports a policy decision which will inevitably be based

on a calculated risk

In order to fit in with the decision-making process, the cost-benefit analysis can be carried out in two stages In the initial phase of the decision-making process, a large number of alternatives can be analysed overall on the basis

of ‘pre-feasibility studies’ Once clarity has been reached on the alternatives on which the research will be focused, a more in-depth cost- benefit analysis can be carried out The final decision will be made by politicians, on the basis of clear and relevant information

Between the moments when the idea for a large project is first formulatedand a complete “Planologische Kernbeslissing” (Key Planning Decision) isfinalised, there are many instances, spread over a number of years, whenpolitical choices must be made The initial ideas are normally based on anotion of a problem or an opportunity During this stage, investigations willoften already be carried out to determine whether there is any connectionwith existing policy concepts, such as ‘main port’ or ‘modal shift’ Althoughthis leads to a specific positioning, it does not yet afford any insight into thesignificance of the project itself Only research will determine to what extent

an investment project can be used as a means of achieving certain aims.Research is important in almost every stage of the policy preparation processbecause, in each stage, decisions have to be made on how project

alternatives are to be configured On the one hand, it is therefore sensible tocarry out a cost-benefit analysis in the early stages On the other hand, since

so much information is required to carry out a comprehensive cost-benefitanalysis, it is only really possible to carry out a complete analysis at a laterstage

The solution is to take the principles of the cost-benefit analysis as apoint of departure during the problem formulation stage and the preliminaryinvestigation into various project alternatives, but to derive the informationmainly from pre-feasibility studies and overall indicators Overall information

on all relevant topics is therefore available when deciding on the most likelyalternatives for the research Moreover, these ‘pre-feasibility studies’ canprovide information on whether a project is indeed large, i.e whether wideresearch, including the effects which this will have on (the rest of) theeconomy and the environment, is desirable

Research and Decision-making

.

Figure 2.2

Structure of the decision-making process

Before the final decision is made on the project, a comprehensive cost-benefit analysis is carried out In this way, doing a cost-benefit analysisbecomes an iterative process in which more and more sections can be filled

in and improved quantitatively as the research progresses

Obviously, these analyses can never replace the assessments made inpolitical decision-making On the contrary, the aim of these analyses is toensure that political decisions are made on the basis of relevant information

by using unambiguous concepts and clear bases for assessments

Figure 2.2 shows the role of cost-benefit analysis in the decision-makingprocess A distinction is made between two research stages During thepreliminary stage, problem analysis occupies a central position and

‘pre-feasibility studies’ are carried out In the second stage, a comprehensivecost-benefit analysis is carried out prior to making a final decision

The initial research stage: problem analysis and ‘pre-feasibility study’

Large infrastructural projects entail a lengthy preparation anddecision-making process At the start there is an abundance of suggestionsand ideas During the course of the process, these are reduced to only a fewserious project alternatives The quality of the interim decisions to be made

problem opportunities

base case

preliminary phase

decision-making

solutions (projects, other policy)

‘pre-feasibility study’

focusing on alternatives

final problem formulation

project alternatives base case

comprehensive CBA

decision-making

Evaluation of Infrastructural Projects 10

in respect of these many suggestions and ideas depends on the quality ofthe information The quality is thus determined by the research during theentire preparation and decision-making process Research must, on the onehand, prevent unrealistic alternatives from remaining under consideration inthe later stages and on the other hand, prevent usable project alternativesbeing rejected during the initial stages

In addition, a clear problem analysis is important for the quality of the

interim decisions Problem analysis should ensure that attention is notshifted from a general problem to a narrowly defined, technical problem.Good problem analysis can also help in identifying the information which isrequired to make considered decisions

The following questions are raised in a problem analysis:

• problems and opportunities

What are the aims of a project? Improvements of existing infrastructurecan be qualitative (speed, reliability, punctuality) or quantitative(capacity) in nature They may solve existing problems, but may alsomake it possible to use opportunities which are expected to arise

• Solutions

- Is the project the only means of solving the problems or making use

of the opportunities? A type of policy other than infrastructureinvestments (regulations, price policy) may also be considered

- What is the role of the market and the government? The allocation

of tasks between the private and public sectors is closely linked to thenature of the project services The government may undertake theproject itself, but may also assume other roles: a preconditional role(for example within the framework of spatial organisation),

a coordinating role (bringing parties together) or a financial role (as investor) In this respect, an investigation may also be carried out

on whether a public-private partnership is a feasible option

In order to get a clear picture of the problems or opportunities, information

is required on future developments with or without the project The projecteffects become apparent when comparing the two developments A pre-feasibility study of the (project) alternatives can be carried out on the basis

of scenarios Aspects which will be considered include implications for thespatial organisation, legal issues, transport flows, impact on the environmentand costs It is very important that these effects are shown systematically, ineach case as the difference between the (project) alternative and the base case The initial stage of the research is therefore largely concerned with making

an inventory It is more important that all relevant topics are taken intoaccount than that thorough research is carried out on only a number ofsections In this stage, it is often sufficient to use information derived frompre-feasibility studies which have been carried out during other researchprojects.2

2) See for example the information in AVV (1996), the OEEI report TNO Inro et al (2000).

Notes

Research and Decision-making

This stage also seems to be the appropriate time to conduct discussions onthe usefulness and necessity of the project Problems and opportunities andthe significance of various infrastructural and other policy possibilities havealready been identified It is of great importance that the fundamental issuesare already discussed at this stage to prevent the initial choices and

demarcations still being under discussion at a later stage in the process

A pre-feasibility study can help to put the correct assessments inperspective and to support the political-administrative decisions in respect

of project alternatives The aim is to prevent irrelevant alternatives fromremaining in the foreground and relevant alternatives from disappearing intothe background A thorough broad cost-benefit analysis at the end of theinitial research stage prevents a more in-depth, comprehensive profitabilityanalysis during the second research stage from being at right angles to thepreparation and decision-making process

The second research stage: a comprehensive CBA

The second stage commences with a political decision on the areas ofresearch to which ‘the project’ will be restricted These areas may in practicestill be interpreted broadly Examples are the Research into National Airports(ONL) and the Project for the Main Port Development in Rotterdam (PMR)

In a broad approach, the comprehensive assessment of diverse solutions isshown to its full advantage in a comprehensive cost-benefit analysis

In addition, social discussion and cost-benefit analysis progress in step witheach other A broad approach prevents the discussion from narrowing to

a derived problem with only one technical solution

The environmental impact assessment MER required by law is carried outsimultaneously with the cost-benefit analysis The aim of the MER is torecord the consequences for the environment and nature, but does notweigh this up against other interests The aim of the CBA is to determine thesocial-economic return – including effects on the environment and nature.Therefore these studies should be geared to one another They must becarried out from the same point of view and an exchange of informationmust be possible A cost-benefit analysis cannot be carried out properlywithout knowing what impact the project will have on the environment

In the same way, the MER requires economic impacts in order to accuratelyforecast the impact on the environment Both the cost-benefit analysis andthe MER also require information derived from, for example, transportstudies, landscape studies and cost studies

The remainder of this report will concentrate on the (comprehensive) benefit analysis carried out during the second stage of the decision-makingprocess The pre-feasibility study carried out in the initial stage has a similarstructure, but will, in general, not be as fully elaborated

cost-3 Project Effects

Project effects can be defined as the differences between the developmentwith and the development without the implementation of the project Theaim of a cost-benefit analysis is to determine the value which societyallocates to an impact This chapter considers the types of project effects(section 3.1) and the valuation of the effects (section 3.2)

We can distinguish between project effects by asking five questions: does it have an impact on the Netherlands? Are there market prices for the impact? Does it involve extra welfare or a different distribution of welfare? Does it involve a direct or indirect effect? Does the effect affect operators, users or third parties? Based on these criteria, it is possible to distinguish between types of project effects

The effects of a national infrastructural project can be characterised on thebasis of five criteria:

1 Do the effects affect the Netherlands or foreign parties? This criterion

is important when considering the question of whether the Dutchgovernment would have to contribute financially to the investment

2 Is it possible or impossible to price the effects according to market

prices? This distinction has a practical significance since there are nomarkets or market prices for many impacts of infrastructure Think forexample of journey time savings made by users and aspects relating tothe environment, nuisance and safety

3 Does an effect signify a different size of the national welfare or only a

different distribution of the existing or new welfare? The first case relates

to an improvement in efficiency This criterion distinguishes a

cost-benefit analysis from other forms of project appraisal

4 Do the effects on the economy arise directly from the project, or are

these effects derived from direct effects? The distinction between direct and indirect effects is used to show the causal effect of a project In

respect of indirect effects, the distinction is often made between forwardand backward effects A forward effect causes a change for the

customer; a backward effect leads to a change for a supplier

5 Which parties are affected by the benefits and disbenefits of the effects:

owners or operators of a project, customers of the project services orthird parties? This criterion is important when considering, for example,

a government contribution to the development, any public-privatepartnerships and compensation of non-priced external effects

Evaluation of Infrastructural Projects 14

Based on these criteria, a diagram (see Figure 3.1) has been drawn up toclassify the most important types of economic effects of a project

Horizontally, the cells are arranged on the basis of criteria 1 (domestic/foreign), 2 (priced/non-priced) and 3 (redistribution/efficiency) Vertically,criteria 4 (direct/indirect) and 5 (operators/users/third parties) were used

a In the cells of the diagram, examples are given in italics.

Many of these effects are explained in the text box ‘Examples of projecteffects: construction of a high-speed rail link’ No attempt was made to beexhaustive, although attempts were made to explain certain concepts

Examples of project effects: construction of a high-speed rail link

This example relates to the introduction of a high-speed rail link In thisrespect, No attempt was made to be exhaustive; not all effects will bediscussed The intention of the example is to explain the concepts behindthe division of project effects in Figure 3.1

operating profits

If the return from the sale of project services (ticket sales, development

of stations) exceed the costs of development (personnel, trains etc.),

an operator makes a profit The operator compares this profit to a part ofthe investment amount Only if the operator still makes a profit afterdeducting capital costs – surplus profit to economists – is it possible totalk of a welfare profit in social terms, which in this case, is also called(producer) surplus

number of journeys and journey time profits

The construction of a high-speed rail link leads to additional sales ofproject services For example, the number of train journeys increases The additional sales are a direct consequence of increased efficiency inproduction and consumption times and are therefore a welfare effect

In addition, the high-speed train journeys will be faster than journeyswith ordinary trains The benefit of the high-speed raillink consiststherefore (mainly) of journey time profits While journeys are a pricedgood, a market price for the time (of the journeys) is not immediatelyapparent It is therefore a non-priced welfare effect

uninsured risks journey time profits,safety air pollution, noise effects on other

modes strategic effects

congestion regional inequality

congestion exchange rate effect

journey time profits air pollution

operators

users

third parties

welfare estimate The Netherlands

priced effects non-priced effects

redistribution efficiency efficiency redistribution

foreign countries

.

Figure 3.1

Typology of project effects a

Project Impacts

safety and uninsured risks

Let us assume that a high-speed rail link is riskier than an ordinaryrailroad The risk of an accident and the consequences thereof are notinsured separately and are insured only to a limited extent A market pricefor this risk is therefore not known Not only do the users carry an extrarisk, but if the users are able recover the consequences financially fromthe operator the shareholders too run an extra risk A cost-benefitanalysis should take the extra risk in respect of accidents intoconsideration and should, where possible, give it a value

air and noise pollution

Directly involved parties also include those people living in the area whoexperience nuisance from the railway (think of noise pollution and alsothe consequences for accessibility and the visual damage to theenvironment) In addition, the project will also have a more generalimpact on the environment (consider, for example, changes in energyconsumption and CO2emissions) These are all examples of welfareeffects

effects on other modes of transport and congestion

As a result of the high-speed rail link, a number of travellers will choose

to take the train and to leave their cars at home The shift betweenmodes has a (positive) social value if the high-speed rail link reducestailbacks on motorways or if cars cause more damage to the environmentthan the train Only a part of all the consequences of car use is therefore

a welfare effect In respect of the remaining consequences, a change inefficiency is lacking

strategic effects and regional inequalities

The high-speed rail link will have an influence on where companiesdecide to locate their premises and, in this respect, it can have strategiceffects It is conceivable that a (further) clustering of activities will takeplace around the high-speed rail link station This could have a positivesocial value if companies benefit from each other’s proximity,

for example, by lower communication costs, or if proximity leads to moremutual competition Although it is difficult to determine the extent of thewelfare profit, this should nevertheless be included in a CBA

The high-speed rail link could also have consequences for the distribution

of production and income between countries and regions It could, forexample, increase productivity in a relatively underdeveloped region atthe cost of another region which would, in turn, reduce inequality.Although this redistributive impact will not be valued in a cost-benefitanalysis, it will be determined

According to a CBA, a project is socially profitable if the beneficiaries can,

in principle, compensate the non-beneficiaries financially

This compensation does not however actually have to take place

The annual benefits and disbenefits are expressed in a CBA in monetary terms and are added up over time to form the net present value The scope

of a CBA is not unlimited; some project effects either cannot be expressed

in monetary terms or it is very difficult to do so

Evaluation of Infrastructural Projects 16

An infrastructural project is normally proposed in order to achieve specificaims In order to assess whether a project fulfils the aims, it is cruciallyimportant to draw up a meticulous inventory and description of the projecteffects Considered from a social-economic point of view, an infrastructuralproject should only be carried out if all returns counterbalance all investmentcosts and the broadly defined social welfare increases as a result of theimplementation of the project

One of the reasons for building a high-speed rail link is, for example,

to present an alternative for medium range travel which will eventuallyabsorb some of the growth in air and motor traffic over this distance The intended effects are time-saving for motorists, cost-saving for airtravellers and a reduction in environmental damage Appraising such aproject according to a list of operational aims is not a simple matter becausethe aims could be mutually contradictory Furthermore, the aims should not

be achieved at the cost of everything else A compromise between the(partial) realisation of the aims and the costs associated with this is oftendesirable

A CBA offers a framework within which such an appraisal can be made

A great advantage of appraisal method is that it allows a comparison to bemade between the various benefits and disbenefits of the project (costsavings, time savings, environmental effects and investment costs) byreducing them, wherever possible, to the same denominator, namelymoney

The idea behind this is simple The economic agents (households andcompanies) which are directly or indirectly affected by a project can revealtheir preferences clearly in terms of money or income They are willing topay an amount of money if a project is carried out because they will benefitfrom the project (willingness to pay)3 A comparable situation arises inrespect of non-beneficiaries (willingness to accept) This implies an individualtrade-off between the benefits or disbenefits of a project and a sum ofmoney

If the sum total of such amounts of money – the positive of gainersand the negative of losers – is positive, then the customary requirement has been met in order to appraise the project as being socially profitable This requirement entails that the gainers must be able to compensate thelosers – in monetary terms – fully4 The compensation does not actually have

to take place

One profitability criterion?

Practice is more complicated than theory The text box ‘Valuation ofeffects in practice’ explains further how impacts can be expressed inmonetary terms Individual effects are mostly determined and valued peryear All individual effects expressed in monetary terms must therefore first

of all be balanced per year This results in the cash flow over the relevanttime horizon5 The cash flow is, in principle, initially negative on account ofthe investment costs At some time after the project had been implemented,the returns should exceed the expenses so that a positive cash flow can beachieved Subsequently, the cash flow must be discounted and added up.This gives the net present value

3) Or the opposite: they are, in exchange for an amount of money, willing to accept that the project will not be carried out and that they will not enjoy the benefits (willingness to accept).

4) In economic literature, this criterion is known as the Hicks-Kaldor criterion and is often indicated as

a ‘potential Pareto improvement’ (see the text box below).

5) The cash flow only includes actual income and expenditure Write-offs therefore are not included

Notes

Project Impacts

The risk related to a project often complicates matters Officially, the free actual discount rate is 4% per annum (Ministry of Finance, 1995)

risk-A current effect therefore is weighted approximately three times more than

an effect 25 years later The difference is not so great that the impact can bedisregarded after 25 years, in particular not if, at a continued economicgrowth, the future impact is significantly greater than the current impact.The uncertainty in respect of the effects after 25 years however is great Thisproblem will be examined in section 5.2 For the time being however theconclusions drawn from chapter 5 will be sufficient According to these, acost-benefit analysis must identify the risks and uncertainties and, whereverpossible, value them Furthermore, there are measures other than the netpresent value which can be used when appraising the risks and uncertaintiesrelated to a project

One criterion?

In chapter 2, we mentioned that not all project effects can, in practice,

be expressed in monetary terms The criterion that gainers should be able to

compensate losers, for example, does not take distributive issues into

consideration People living in the area often experience nuisance from theproject while they do not actually benefit, or benefit only slightly, from theproject An infrastructural project could also specifically aim at redistributingthe welfare, for example, to improve the economic position of

underdeveloped regions A cost-benefit analysis obviously has to take such

an aim into consideration and must stipulate the possible consequences forthe welfare distribution It is however seldom possible, if at all, to expresssuch an impact in monetary terms6

Another objection to the criterion of financial compensation relates to the

individual valuation of non-tradable goods and services, such as noise or anexceptional landscape This is not always easy to estimate The customarymethod is to derive the valuation from the behaviour of the users Markettransactions say a lot about the willingness to pay or accept This methoddoes not work very well, or does not work at all, if markets function badly

or if markets do not exist An amount is then not naturally derived frombehaviour

Inadequate or non-existing markets impede the valuation ofenvironmental effects The issue is how, for example, to express extranuisance from noise or increased air pollution in monetary terms This issue

is also raised when valuing leisure time, risks for tax payers, cluster benefitsetc The problems are even greater when valuing a unique area of naturalbeauty There are also other things which cannot be expressed in monetaryterms, or which are monetised with great difficulty Legal security is anexample of these

The comments relating to the criterion of financial compensation make itclear that the possibilities of quantifying and monetising in a cost-benefitanalysis are not limitless Limitation refer in particular to distributive issuesand the valuation of some non-tradable goods (environment, nature, risks).These impacts are indicated (quantitatively as far as possible) in a social cost-benefit analysis, but are not expressed in monetary terms The appraisal of aproject therefore often has to be made according to several different criteria

6) A cost-benefit analysis can only express the redistribution in monetary terms if the principle of individual valuation is abandoned and if different weights are allocated to the benefits or disbenefits for various parties

Notes

Evaluation of Infrastructural Projects 18

Figure 3.2

Change in the consumer surplus

Valuation of effects in practice: consumer surplus

One of the welfare theory criteria for social profitability is that a projectmust signify a Pareto improvement, i.e a situation where some peopleare better off as a result of the project and no-one is worse off This isgenerally regarded as too demanding a criterion which few or no projectscan fulfil The Hicks-Kaldor criterion says that, by compensating for thedisbenefits, a situation could arise in which a project benefits some peoplewhile at the same time not disbenefiting anybody This criterion has morescope than the Pareto improvement; it could be seen as a potentialPareto improvement

Establishing whether or not a project signifies a potential Paretoimprovement is, in principle, a scientific exercise In practice, it is notalways easy to calculate a potential Pareto improvement In order toestablish whether a project signifies such an improvement, the concepts

‘willingness to pay’ and ‘consumer surplus’ have to be considered

It is easy to calculate the change in consumer surplus for products forwhich a price exists This is represented by the shaded are in Figure 3.2

The demand curve in the figure indicates what consumers are willing topay for various quantities If, as a result of the project, the price changes

from p0to p1and the demand increases from q0to q1, then consumer

surplus increases Consumers who have already agreed to pay price p0(namely q0), are willing to pay more than what is necessary after theimplementation of the project For them, this implies an expense or costsaving represented by the rectangle A The combination of the drop inprice and the rise in consumption is part of the total change in welfare(the triangle B) A formula for the shaded area is:

(p0 – p1)q0 + 1(p0– p1)(q1– q0) = 1 (p0 – p1)(q1+ q0)

The second expression for the area is often called ‘the rule of half’ This formula is often used in practice, for example, in transport research.The expression indicates the change in the consumer surplus The sum ofall the surpluses gives an approximate indication of whether a potentialPareto improvement has taken place and therefore of whether the project

B

demandquantity